Question

EX 11-4 Entries for issuing bonds and amortizing premium by straight-line method Obi. 2 Smiley Corporation wholesales repair products to equipment manufacturers. On April 1, 20Y1. Smiley issued $20,000,000 of five-year, 9% bonds at a market (effective) interest rate of 8%, receive ing cash of $20,811,010. Interest is payable semiannually on April 1 and October 1. Journalize the entries to record the following: a. Issuance of bonds on April 1, 20Y1. b. First interest payment on October 1, 20Y1, and amortization of bond premium for six months, using the straight-line method. Explain why the company was able to issue the bonds for $20,811,010 rather than for the face amount of $20,000,000.

Answer 1

Solution Face Value of Bonds Issue price of Bonds Premium on issue of Bonds ($20,811,010 - $20,000,000) Coupon Interest rate Market interest rate Bond life Interest payment frequency Total no. of interest payment till maturity (5 Years x 2) $20,000,000 $20,811,010 $811,010 9% 8% 5 Years Semi-annual 10 Semi-annual interest payment = $20,000,000 x 9% x 6/12 = $900,000 Required a.: Journal entry to record issuance of bonds on April 1, 2011 Credit Date April 1, 20Y1 Ich Debit $20,811,010 General Journal Cash Bonds Payable Premium on Bonds Payable (To record issuance of bonds) $20,000,000 $811,010 Required b.: Journal entry to record first interest payment and amortization of bond premium Step-1: Calculation of semi-annual interest expense using straight-line method Total interest payment during the entire Bond life ($900,000 x 5 Years x 2) Payment on maturity of Bonds Less: Issue price of Bond Total Interest expense to be recognised during the entire Bond life $9,000,000 $20,000,000 ($20,811,010) $8,188,990 Semi-Annual Interest Expense to be recognised ($8,188,990 / 10 semi-annual periods) $818,899 The Smiley corporation shall record the $818,899 as interest expense on each interest payment date. Semi-annual interest payment ($20,000,000 x 9% x 6/12) Semi-annual interest expense Semi-annual premium amortization ($900,000 - $818,899) $900,000 $818,899 $81,101 Step-2: Journal entry Dehit | Credit $818,899 $81,101 Date General Journal October 1, 20Y1 Interest Expense Premium on Bonds Payable Cash (To record first interest payment and premium amortization) $900,000 Required c.: Since, the coupon rate of interest on the bonds is higher than the market rate of interest, these bonds shall provide higher returns to the investor on their investment as compared to the market return, and hence the investor shall be willing to pay premium above the face value of the bonds to buy these bonds. Therefore, the company was able to issue the bonds for $20,811,010 rather than for the face amount of $20,000,000.